Governance Solutions: The Ultimate Guide to Competence and Confidence in the Boardroom

By David A. H. Brown and Debra L Brown

This is not just a book “about governance”, it tells you how to “do governance”.

Authors David A. H. Brown and Dr. Debra L. Brown deliver:

• Proven Governance Solutions: It is a single source—the ultimate guide—for solving your governance problems.
• Access: It includes almost 70 gove

• Language: English
• Publisher: Author Academy Elite
• Release date: Jan 3, 2020
• ISBN: 9781647460303

David A. H. Brown

Canada's leading thinker, speaker, writer and practitioner in corporate governance, David has co-founded over a dozen board governance education programs including university accredited certification programs in Canada and abroad. Having served both as a CEO and a Board member, David is well-positioned to help corporations deal with issues in the boardroom. Principles-based governance underpins all of his work, and is foundational to corporations selecting the right governance model and board practices. This framework has been adopted by organizations as diverse as leading telecom providers, banks and credit unions, government agencies and Crown corporations, universities, health authorities, pension funds and military commands. David has worked at the board and CEO level with hundreds of major private, public and not-for-profit sector corporations in Canada and internationally in the field of governance, in countries ranging from Bahrain to Malaysia, Guatemala to South Africa. He helps organizations strengthen their governance practices through diagnostics, benchmarking, dialogue, seminars, workshops and hands-on custom work with boards.

Book preview

With so many spotlights trained on corporate boards, there could hardly be a better moment for hands-on, cutting-edge guidance on how directors can power success—and avoid traps. David and Debra Brown are world-class experts; their new book earns a place on director desks everywhere.

Stephen Davis, Ph.D.

Associate Director and Senior Fellow, Harvard Law School Programs on Corporate Governance and Institutional Investors

A major benefit of this book is that it applies to any board member, in any sector, in any country! Truly an internationally relevant piece of work!

Spencer Cameron

Deputy Editor, Ethical Board Group | Ethical Boardroom

This insightful book brings governance to life in a practical and helpful ultimate guide. The level of wisdom and common sense shared is a real difference maker!

Michael J. Soligo, M.A.Sc., P.Eng.

C.Dir., President & CEO, RWDI

Experience matters. Debra and David Brown have it. They have long been key figures in Canadian corporate governance and in governance generally. Their knowledge in the areas of governance, leadership, and business management is estimable. Read their book and you will see that for yourself.

Hoffer Kaback

Former Lead Columnist, Directors & Boards Magazine, Former Director of U.S. Public Companies and Not-for-profit Organizations

The line between board and management just became crystal clear for all of us! The board governs—management manages—the organization flourishes. That’s why boards exist! Fantastic book!

Norman Loberg

Corporate Director, Chair of the Board, Alectra Utilities

Every reader will come away from this book with deeper insights into corporate governance, including an appreciation of the need for excellent practices in the boardroom. This book is particularly relevant given new challenges confronting corporations, ranging from cyber security threats to stakeholder activism and increased scrutiny from regulatory authorities. The Browns have produced a high-quality reference for benchmarking and improving corporate governance.

Gordon van Welie

President and Chief Executive Officer, ISO New England

I am so impressed with this book. It covers all the right things and does it extremely well. Everything any board member needs to know to do their job is in this guide.

Gary Seveny

Corporate Director; Chair of the Board, Yorkville Asset Management,

Retired CEO, Alterna Bank

Governance Solutions has proven to be a literal Godsend for our ministry. I have, on occasion, been able to spend time with other CEOs of similar-sized non-profits (and even many much larger), and, when the topic of Boards and governance comes up, I realize just how fortunate we have been to work with Debra and David Brown. EE has a clearly articulated and commonly shared mission and vision, a simply amazing Board of Directors, and an organization with the tools necessary for positive direction and control, which ultimately means less waste in time, talent, and resources, and more accomplished by the Ministry! During EE’s transition after the loss of our founder, Dr. D. James Kennedy, the ministry not only survived, but thrived and in no small part due to the assistance of Governance Solutions.

John B. Sorensen, D.D., D.H.L.

President/CEO, Evangelism Explosion International

The Browns certainly have not disappointed with this ultimate guide. I have read their articles and periodicals with extreme interest over the years and this time they have more than outdone themselves! The governance gurus have given us the ultimate in Governance Solutions.

Dan Swanson

President, Dan Swanson and Associates, Ltd.

There has never been a time when good governance was needed more than it is today. The rapid pace of change, the enormous potential of technological innovation, the vast opportunities around the world, the almost unquantifiable consequences of risk make this book perfectly timed for a such a perfect storm!

Dr. Michael Hartmann

Principal of the Directors College, Executive Director, EMBA in Digital Transformation, Co-Director, Health Leadership Academy, DeGroote School of Business, McMaster University

This is an impressive book! Current, relevant, practical and readable! I highly recommend this book to any board member or executive wanting to dramatically increase their competence and confidence in the boardroom!

Roberta S. Brown

President, Sassafras River Associates, Retired Utility Executive, Former Board Member and Nominating and Governance Committee Chair, ISO New England, Former Board Member IESO

This is not Board Governance for Dummies. This is a smart, easy to follow guide for anyone who is considering standing up a board for their business, joining a board for the first time, or who is assessing the effectiveness of an existing board of directors. David and Debra Brown employ their considerable expertise to guide us through the steps required for an engaged board to be fully knowledgeable about their role and provide the most effective oversight for any type of organization. As the CEO of a highly regulated institution, this book provides my institution a comprehensive guide for board self-assessment.

Brenda Frank

President and Chief Executive Officer, Yankee Farm Credit

GOVERNANCE SOLUTIONS

THE ULTIMATE GUIDE TO COMPETENCE AND CONFIDENCE IN THE BOARDROOM

DAVID A. H. BROWN

DR. DEBRA L. BROWN

Copyright © 2019 by Governance Solutions, Inc.

All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means without written permission of the author.

Edited by Alex Martin, Dave McComiskey, Hannah Rariden, and John Sorensen. Cover design by Hannah Rariden.

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means—for example, electronic, photocopy, recording—without the prior written permission of the publisher. The only exception is brief quotations in printed reviews.

Paperback: 978-1-64746-027-3

Hardback: 978-1-64746-028-0

Ebook: 978-1-64746-030-3

Library of Congress Control Number:

The information included in this book is for educational purposes only. It does not replace any legal advice from your attorney, general counsel, or legal firm. The information contained herein is provided without any representation or warranties, be they express or implied. Mention of specific companies, organizations, or authorities does not imply endorsements by the authors or publisher, nor does mention of specific companies, organizations, or authorities imply that they endorse this book, its authors, or publisher. The publisher and the authors disclaim any liability for any legal outcomes that may occur as a result of the application of the methods suggested in this book. Some names and identifying details have been changed for confidentiality.

DEDICATION

…to the hundreds of boards and thousands of directors and executives who taught us everything we know!

TABLE OF CONTENTS

GOVERNANCE AND STRATEGY

Introduction

1 Conceptual Model

2 Roles And Responsibilities

3 Five Types Of Boards

4 Director Conduct

5 Strategic Thinking And Planning

GOVERNANCE AND RISK

Introduction

6 Linking Strategy To Risk And Reporting

7 Risk Governance And Oversight

8 Corporate Social Responsibility

9 External Communications And The Board

GOVERNANCE AND PEOPLE

Introduction

10 Leadership In The Boardroom

11 The Chair Of The Board

12 Committees Of The Board

13 Ceo Succession, Selection, And Delegation

14 Ceo Evaluation And Compensation

15 Before, During, And After Meetings

16 In-Camera And Executive Sessions

17 Board Evaluation

18 Board Orientation & Onboarding

19 Board Renewal And Profiling

GOVERNANCE AND RESOURCES

Introduction

20 Financial Direction Role #1

21 Financial Governance Role #2

22 Accounting Principles

23 Financial And Governance Disclosures

24 Monitoring Financial Performance: Role #3

GOVERNANCE CULTURE AND BEHAVIOUR

Introduction

25 Understanding Boardroom Culture

26 Forging Healthy Boardroom Behaviour

27 Asking Questions

28 Director Liability

29 Integrity In The Boardroom

30 Some Final Thoughts

Acknowledgements

Personal Acknowledgements

Preface

Boardroom dysfunction is rampant. At times CEO’s and other C-Suite executives wish they could avoid board meetings like the plague. Boardroom bullies cause disruption and strained relationships. The board chair is either ineffective or in over their head. Board members don’t know what they are supposed to do, feel overwhelmed, and try to do the job of management. Management almost unknowingly makes things worse by dragging their board into operations, all the while complaining about it.

Okay, so perhaps these statements are an over-exaggeration for some. But, for many they ring far too true.

The solution to these and other boardroom issues is for board members, the CEO, and the rest of the management team to be clear on their jobs; to know where the bright red line between operations and governance is drawn. In other words, who does what in governance and how is it done?

What these leaders need are more tools not more rules!

Governance Solutions: The Ultimate Guide to Competence and Confidence in the Boardroom is chock full of governance tools that will build confidence and competence, make the complex seem simple and bring order to the chaos.

Divided into five sections, this book covers the full spectrum of board governance giving the reader deep insight into:

Governance and Strategy

Governance and Risk

Governance and People

Governance and Resources

Governance Culture and Behaviour

This is the ultimate guide for board members and executives regardless of sector–private, public and not-for-profit. Whatever the jurisdiction in the world, this guide remains a highly relevant resource. Designed to build both competence and confidence, its principle-based approach allows any reader interested in governance to benefit from its solutions and tools.

This is not just a book about governance, it tells you how to do governance.

Practical and comprehensive, everything you need to succeed in the boardroom can be found in this one place. There are principles, tools, and clear explanations of the board’s role for all five levels of governance: strategy, risk, policy, people, and resources. And, it includes profound insights into, and tools for, boardroom culture and behaviour—those less tangible but substantial aspects of effective governance, oversight and leadership.

This ultimate guide will deepen the governance understanding of even the most seasoned leader. Readers will understand the depth and breadth of how to add value and provide strategic oversight to any organization. From the role of the board in strategy and risk oversight, effective policy setting and compliance reporting, successfully navigating the board’s relationship with the CEO, succession planning, and protecting and stewarding the company’s financial and other resources, to governance systems, committee structures and meeting processes, this book has solutions designed to help you succeed and excel.

Authors David A. H. Brown and Dr. Debra L. Brown each has almost 30 years of direct and practical experience working full-time with boards. Comfortable and confident with both boards and executives, their mix of well-researched, experiential and conceptual insights uniquely qualify them to advise organizations on their governance. Both have served as CEOs, reporting to boards, and as board members of varied organizations, including as Board and Governance Committee Chairs. They can see governance issues from both sides of the boardroom table. They know what works and even more importantly, what does not!

Their depth and breadth of knowledge and practical, principle-based approaches will give the reader:

Access to almost 70 governance concepts and tools unique to this book

Rich, broad, applicable governance knowledge

Competence in their governance roles, responsibilities, duties and accountabilities

Confidence in their boardroom leadership

Success in overseeing the direction and control of the organization

Tools for building strong relationships and a high-functioning boardroom dynamic

Insight and clarity on how to create a healthy boardroom culture

Personal satisfaction with their contributions to the organizations they serve

I.

GOVERNANCE

AND

STRATEGY

INTRODUCTION

Have you ever wondered why boards exist? We begin by answering this fundamental question. Do they add value to the organization or are they purely there for show—like parsley on a plate?

We begin at the beginning - considering why boards exist from an economic point of view and explore Principal Agent Theory. You will learn how and why boards are the independent intermediary between the economic self-interests of the principals and those of the agents. In addition, you will explore how boards are expected to act in the best long-term interests of the organization and why they must consider the needs of all the organization’s stakeholder groups.

In chapter two, we define corporate governance as the system by which the organization is directed and controlled.¹ As you explore what this system looks like you will learn about the key roles and responsibilities every board has. Together we unpack the tools which the board has at its disposal to carry these out.

In the third chapter, you will learn about the different models of governance that exist and we ask you to think about which governance model might be best for your organization given its maturity and operating environment.

You will discover how governance is optimized over the course of time; and that in a mature organization further along in its lifecycle, a reform governance model fulfills all the requirements for a board to be fully effective.

Chapter four unpacks director conduct and the duties of loyalty and care. You will review the statutory duties and the hierarchy of legal documents which directors must be aware of (statute law, common law, regulations, bylaws, policies, and procedures). And, gain insight into how those duties are easily fulfilled when viewed as values to be lived out in the boardroom.

You will take an in-depth look at the principle of empowerment, considering how to push decision-making authority as far down the organization as you can.

Governance is the servant; purpose is the master! That’s why, in the final chapter of this section, you will look at the board’s role with respect to strategy. Your strategy should drive your governance—it is not the other way around. Everything that happens in the organization should be the product of and aligned with strategy. We discuss in detail the board’s role in establishing the organization’s mission, vision, values, goals, objectives, targets, ranges, and weightings. And you will explore the tools that a board, together with management, can use in order to develop the optimal strategy for the organization.

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¹ Sir Adrian Cadbury: Cadbury Committee, Financial Aspects of Corporate Governance, (UK: 1992), p.14.

-1-

CONCEPTUAL MODEL

WHY DO BOARDS EXIST?

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest.

Adam Smith – Wealth of Nations

Why do boards exist?" If you’ve ever worked for a board or with a board, you have probably asked yourself that question.

You may even believe that boards are really like parsley on a plate. They take up space, they look pretty, but they add little nutritional value.

We would argue that boards need to add nutritional value. They need to be much more than parsley on a plate.

So when we ask ourselves the question, why do boards exist?, we looked to a fellow by the name of Sir Adrian Cadbury who probably gave us the best answer to that question to get us launched on our journey.

Adrian Cadbury was the head of the Cadbury Food conglomerate in the United Kingdom. He was invited by the London Stock Exchange and the British government to look into a series of failures of major companies in Britain in the 1980’s.

Britain, like many of the economies of the world, suffered serious economic downturns in the 1980’s, and Cadbury struck a committee to look into why they had failed. The committee’s goal was to discover what might be done to stop corporations and organizations from failing in the future.

The Cadbury Report was published in December 1992, which launched the corporate governance reform movement. Essentially, Cadbury’s answer to this question of why boards exist? was that they exist to run the corporate governance system of their organizations. Cadbury and his committee defined corporate governance as the system by which organizations are directed and controlled.

They observed that in every case where these corporations had failed, the failure started with something going wrong in the day-to-day operational system—the system that produces and distributes products and services to clients of the organization. Moreover, he observed that this finding applied to all sectors: private, public, voluntary, and cooperative.

He suggested that when something went wrong in the operational system, whether that operational lapse lead to organizational failure or not, that failure was largely the function of how well the governance system was working.

Furthermore, he discovered that in the corporations that failed the governance system had been subsumed into the operational system. In plain language, it was under the control of the CEO—the CEO was running both the operational and governance systems. The boards in these cases were simply parsley on the plate.

Cadbury observed that when something went wrong with the operational system (such as a lapse in one of the functions) it was because the governance system was so integrated into the operational system—under the same hierarchy and people—that there was a circularity in accountability; and it failed to detect and correct that lapse.

What Cadbury discovered has become the fundamental thesis of corporate governance reform—if the governance system is independent from and above the operational system, then it’s more likely to be functional and effective to detect and correct lapses in the operational system.

This is the notion of independent control, which is the independence of the governance system. The most important line in the Cadbury report is that boards must be responsible for the governance of their firms, not the CEO.

Even though CEOs and management teams know more about the business model in the organization than boards can ever hope to know, Cadbury argued that boards must oversee the governance system precisely because they are different people.

They are at arm’s length from management. They need to be able to think and act independently. They need to direct the operational system in order to detect and correct issues as they arise. This is what he meant by the word control. And this is what we mean by corporate governance. Ultimately, this is why boards exist—to set the strategic direction or to be the rudder of the ship, aiming it towards a point in the horizon.

Once the rudder is set and the ship is sailing, the board must not abandon it but must maintain control in order to gain a reasonable assurance that the ship is traveling substantially in the direction that it’s been aimed—detecting and correcting any lapses in the operational system that would take it off course.

As we go throughout this book, we are going to unpack how boards do that in practice.

One thing that Cadbury realized early on in his work is that before 1992, when his report was produced, most people thought that all it took to be a board member was common sense.

It was assumed that governance systems didn’t require any special skills or training. By the time you were elected or appointed to a board, you would know everything you need to know to govern, direct, detect, and correct any lapses in operational systems.

Cadbury declared, That’s not true. I don’t accept that. Because if it was true, why would we have all these organizational failures? Running a governance system cannot be simply common sense. It is a business function. It is a system in and of itself. The principles, practices, skills, and tools needed to be effective as a board member must be taught. They can be learned.

Since 1992, business schools and books have embraced corporate governance as an academic discipline, offering graduate degrees. It is possible to earn a doctorate in governance. You can have a career in corporate governance. In the years since Cadbury’s report, it has become a full-fledged business discipline just like marketing, procurement, quality control, accounting, IT, finance, human resources, or any of the functions that make up the operational system.

After the Cadbury report was published, it certainly caused some waves; but it was not universally accepted. Even today it lacks full acceptance by some.

The London Stock Exchange and the British government did however embrace its findings. The Stock Exchange in Britain made the recommendations of the Cadbury report mandatory, listing requirements of public companies in the UK.

This got the attention of people around the world who were struggling with the same operational and governance issues. Similar committees were formed in other countries. In the Netherlands, the Peters Committee was formed; in South Africa, the King Committee; and in Canada, the Dey Committee.

A Toronto lawyer by the name of Peter Dey was the former head of the Ontario Securities Commission. He chaired the Corporate Governance Committee of the Toronto Stock Exchange. Immediately after the Cadbury report had been adopted in the UK, Dey was commissioned to look at the same question: why do corporations fail? How do we keep them from failing in the future?

Dey’s report was published in December 1994 with the self-explanatory title, Where Were the Directors?

He had reached the exact same conclusion as Cadbury—every organizational failure starts with a lapse in the operational system. But if you have directors (the people responsible for the governance system) in place who are effective, active, independent, competent, and doing their job, they tend to detect and correct operational lapses, right the ship, and get things back on track.

Dey’s report contained fourteen recommendations which were adopted by the Toronto Stock Exchange as listing requirements for public companies in Canada. In 2003 when the Canadian Securities Administrators (the various Provincial and Territorial Securities Commissions in Canada led by the Ontario Securities Commission) took responsibility for corporate governance guidelines and enforcement in Canada, they took Dey’s fourteen guidelines and incorporated them as the core of corporate governance guidelines in Canada.

Peters Code was adopted in the Netherlands. King Code was adopted in South Africa. The Cadbury Code was added to over the years and is now called the Corporate Governance Code in the UK. There is a great deal of similarity in each of these reform models of corporate governance in terms of their principles, practices, and choices.

The United States was a little late to come to the table and join the corporate governance reform movement. The 1990’s were a period of unprecedented economic growth for stock market performance in the United States. There was the sense of, What do we need this governance thing for? What are all these other countries worried about?

At one point, Jeff Skilling, the CEO of Enron (one of the ten biggest companies in the US at the time), said, We’ve outlawed the business cycle. We don’t need to worry about recessions and downturns and all that stuff anymore.

But Enron was one of the largest bankruptcies in US history. It was immediately followed by the collapse of WorldCom and several other major corporations in 2001.

In 2002, the stock market dropped severely, and the economy went into recession. Many business leaders and politicians began to wonder, Maybe there is something to this governance stuff. That summer the United States Congress passed the Sarbanes-Oxley Act, which required corporate governance reform principles and practices.

These principles and practices were incorporated as rules of the Criminal Code with criminal enforcement (rules of the Securities and Exchange Commission) that every public company was required to follow. They took corporate governance and reformed governance to a whole new level.

At the end of the day, the fundamental precept of corporate governance reform goes back to Cadbury—a governance system that is separate and independent from the day-to-day operational system. If the day-to-day operational system is under the control of the CEO, then the governance system must be under the control of the board of directors.

We have looked at corporate governance reform and how the founders of corporate governance reform, Cadbury, Dey, and Sarbanes-Oxley, did not invent corporate governance. They elevated and systematized it. Their work, precepts, and concepts were based on corporate law, and corporate law is based on fundamental economic theory.

PRINCIPAL AGENT THEORY

Economic theory helps us to understand why boards exist, and it will help you to understand how you might fulfil your role as a board member.

In the economic concept of Principal Agent Theory, there are two groups of people: principals and agents. The principals are the people who have needs that need to be met.

For those needs to be met, the principals have organized themselves, they have gathered capital to invest, and they have created organizations to meet their needs.

You can think of principals in the public sector as being the taxpayers and the citizens of a country, state, province, or city. The citizens and taxpayers gather together and form a government. They fund that government by paying taxes, and then they expect public services to be provided to them by that government in order to meet their needs.

In the private sector, you can think of principals as the shareholders, creditors, lenders, investors, and other key stakeholders of the organization. They have a need to be met, they have capital that needs to be invested, and they need products and services produced in order to make their lives better—food, clothing, housing, necessities, luxuries, and consumer goods. They are prepared to invest some capital in order to get this corporation going, and they expect returns on that capital as well.

In the voluntary, not-for-profit sector, the principals are the funders, the donors, and the people who establish charities in order to do good works and provide other societal benefits. Again, the principals provide capital to those foundations, charities, societies, clubs, organizations, and associations in order to have social services as well as products produced and distributed to beneficiaries.

Unlike the private sector, where consumers pay the full market price for products and services, one of the unique features of the not-for-profit sector is that principals are prepared to subsidize the price that the client pays for the products and services. Every operational system exists in order to produce and distribute products and services to clients. In some cases, that price is subsidized all the way down to zero so that beneficiaries receive free services from a not-for-profit foundation or charity.

The notion of principals is the same whether these are the members of a cooperative, members of an association, shareholders, taxpayers, or donors. These are the people who create organizations. They have a purpose for the organization that they need it to meet; and they, therefore, contribute at least initial resources and capital to get the organization going.

Principal Agent Theory also identifies a second group of people we call agents. These are the people who undertake the work of the organization. If the principals are the ones who invest capital, the agents are the ones who employ that capital in the enterprise to create change. They are the ones who produce the goods and services, and they are the ones with the ideas on how to meet the needs of the principals.

Agents are the people with ideas on how to utilize resources in order to produce products and services ideas people. Agents produce returns in an economic system. They ultimately create value.

Think of the agents as the CEO, the management team, and the staff. In the voluntary sector, this would include volunteers because many people in that sector generously and freely provide their services.

In the public sector, agents include government employees, the entire public service, line departments, Crown corporations, agencies, boards, tribunals, and the whole machinery of government that produces goods and services for the public’s benefit.

Within every economic system, we have both principals and agents. But we are faced with the reality that the self-interest of the principals and the self-interest of the agents are always in tension with one another. As we’ll see, both groups have different self-interests, goals, and objectives that they want the economic system to accomplish.

Let’s focus for a moment on the dynamics of the system. Every economic system has inputs, which we call resources. These are the operational inputs which allow the system to function. There are generally three kinds of re-sources. Firstly, there are financial resources such as money or capital. Secondly, there are human resources, namely people.

And thirdly, there are material resources, which are the tangible facilities, supplies, materials, and technology that go into an organization. Capital, labour, and material resources are the three inputs or resources which allows every economic system to function.

In every economic system there are also outputs, which we call returns. At the end of the day, every operational system creates and distributes products and services that go out to the customers. Goods and services are the economic returns that every organization produces.

There are economic returns in all three sectors. In the private sector, in addition to returns to the shareholders, there are value added returns to clients and customers. Besides purely economic returns, there are also two other kinds of returns, which we sometimes do not think about in business but should.

The second type of returns are social returns. What do we mean by social returns? Social returns are often seen in the not-for-profit sector. Social returns are, for example, social services and products provided to people for less than their full economic value.

The third kind of returns that enterprises produce are referred to as emotional returns. In academic literature, these returns have been classically called psychic returns, but we generally do not call them psychic returns anymore because the word psychic has an unfortunate connotation to it.

As human beings, we want to do the right thing. We like to do things because they make us feel happy, fulfilled, and content—we want emotional as well as economic returns. Emotional returns are things we do because they are the right things to do. They make us feel good and they are morally ethical. Sometimes, we will sacrifice economic and social returns in order to achieve emotional and ethical (psychic) returns.

Coming back to economic theory, the principals’ self-interest is generally that they would prefer to put the minimum possible amount of resources into every economic system, corporation, and social organization that they are involved with. They want the highest possible return on their investment.

Taxpayers would prefer to pay the least amount of taxes. Shareholders want to invest the minimum amount of money. Donors want the lowest amount of administration costs related to their charitable giving.

In every sector, principals want to minimize the resources that they put out while at the same time they want to maximize the amount that they get back.

Agents, on the other hand, are motivated by different self-interests than principals. Agents are full of ideas. They are people who wake up in the middle of the night with innovative ideas, never run out of thoughts, have infinite visions, but are always dealing with a scarcity of resources. They feel constrained by never having enough money, people, facilities, technology, and supplies. Agents are always wanting more resources for their enterprise.

Agents’ self-interest is to maximize or increase resources in order to have as much as they possibly can to work with. In Principal Agent Theory, they are seen as insatiable in their consumption of resources. Simply put, they will use up as many resources as is available to them because the ideas that they have are infinite. From an agent’s point of view, getting those ideas funded and accomplished is what they are all about.

It is not that agents do not want to achieve high returns for the principals. In all three sectors, management and staff generally (if they are ethical and full of integrity) do want to achieve high returns for the principals. They would love to provide higher levels of social services, public services, and economic value. But the agents understand the operational system better than anyone else, and they understand the third R of economics.

If the first R of economics is resources and the second R of economics is returns, the third R of economics would stand for risk.

What we mean by risk in economic terms is this: for any given amount of resources that go into an enterprise, we do not actually know with certainty what level of returns are going to be achieved. That is what we mean by risk. There are intervening variables, both internal and external. Once we’re out in the open sea in the organizational ship, all kinds of different events can happen over which we have little or no control.

Agents understand risk and are interested in self-preservation. At the heart of human nature, if you are a staff member at an organization, you want to get paid. You also want to keep that job; and, if possible, you want to get promoted and earn bonuses.

Because of their self-interest, agents are much more likely to commit at the lower end of the return spectrum. Because they have infinite plans, it is in their self-interest to maximize the resources that they obtain from the principles. It is equally in the self-interest of agents to commit, promise, or indicate that they will achieve at the lower end of this possible range of returns—minimizing risk to the organization and to themselves.

This principal agent tension is the economic dilemma facing every economic system.

Every economic system that mankind has invented in the last seven thousand years has been designed to resolve this principal agent dilemma. Feudalism, tyranny, aristocracy, oligarchy, communism, socialism, social democracy, and liberal democracy were all designed to find a solution to the principal agent dilemma.

In market economics, we have a very counter-intuitive way of resolving this. As Winston Churchill is famously quoted as saying, Democracy is the worst form of government except for all those other forms that have been tried from time to time.

In our perhaps less than perfect system of market economics and liberal democracy, we say that we are going to find a third group of people—the governors. The governors—or the board—tell the agents, Go out and act in your ruthless self-interest. Don’t worry about how to reconcile the differences between your self-interests. Reconciliation will be the job of the governors.

Principals go out and act in your ruthless self-interest. Shareholders be ruthless about buying and selling your shares. Don’t worry about the effect you’re going to have the corporation. Don’t have a sense of loyalty to the corporations you invest in. Your sense of loyalty is to yourself.

Taxpayers complain about the level of taxes and regularly hold the government to account for using your taxpayer dollars as effectively and as efficiently as possible. Constantly push for higher public services.

Donors push charities in order to minimize how much they are using in administrative costs and maximize the social services that they are returning to beneficiaries.

Agents, if you are not getting the budget approved that you need to get your great ideas funded, you have a choice to walk away. Resign. Go and work for a competitor. Form your own company. Raise your own capital. Don’t put up with the fact that people are under-resourcing you and not funding the great ideas that you have.

Our system of market economics encourages principals and agents to go out and act in their self-interest. We encourage them to go into the marketplace. But to balance and reconcile these self-interests, we introduce a small third group of people: the governors, which are the people who are responsible for what we call the governance system.

We say to that small group of people, We’ll give you the authority and the power to decide what are the right amount of resources that ought to go into this economic system. You will also have to decide what are the optimal amount of returns that ought to come out of this economic system. You decide. The governors will then decide the balance between the resources and the returns which are in the long-term best interest of the organization.

In a macroeconomic system, this group of people are the government. They are the elected parliament, legislature, or congress. In the public sector, it is the legislative arm of government. In the private sector and in Crown corporations, co-ops, clubs, associations, and charities, it is the board of directors or the board of trustees.

The governors are the people responsible for the governance system, and we say to them, You are not allowed to act in your self-interest. You’re the only people in this whole economic system that, once you accept this job, may not act in your own self-interest. If you do, we call that a conflict of interest.

A conflict of interest occurs when one of the governors has self-interest that is potentially in conflict with the best interest of the organization itself. Conflict of interest means you must recuse yourself and not take part in the decision at hand. Decisions in this economic system about what resources go in and what returns come out must be made by unconflicted people. People who govern must set their self-interests aside and think about and act in the best interest of the organization.

This is what we call the fiduciary duty of boards or the fiduciary principle. This committal is written right into the law of corporations. If you look up your act of incorporation, you will find in the section about the powers and duties of the board that the very first line will say that the board of directors must act at all times honestly, in good faith, in the best interest of the corporation.

Fiduciary is an old English word. It means trustee. It means that you have been given custody and stewardship over the business and general affairs of someone else. It is not your money, and these are not your assets. It does not belong to you but instead belongs to other people.

A fiduciary is a trustee who acts with the highest standard of care and is responsible for the business and affairs of a beneficiary who is incapable of looking after themselves. They are helpless. They are like an orphaned child.

There is no way that the beneficiary of this trust would know whether the trustee is being a faithful fiduciary or not. The fiduciary could rob them blind, and this helpless beneficiary would never know. That is why a fiduciary must bring the highest standard of care.

In a corporation, a board is a trustee. They are a fiduciary. And the beneficiary is not the principals but is the corporation itself. This is another strange notion of corporate law. In corporate law, there is a view that a corporation is a person, and it is treated as a person under the law.

We think of a corporation as a separate person legally. It has a birth. It has some sort of life that it lives. It has some sort of unique purpose that it was created to achieve, and it is going to have a death. All British corporate law is written to enable the orderly birth, life, purpose, and eventual death of this person that we call a corporation.

But, of course, a corporation is not really a person. A corporation is a legal fiction, but it is completely helpless. Therefore, the board of directors are the directing mind of this body corporate. They are the mind of this person that we call a corporation. Their job is to be the trustee—the fiduciary responsible to run the business and conduct the affairs of this corporation in its best interest.

Boards are the answer to the principal agent economic dilemma. That is why boards exist from an economic perspective. Boards are there to listen to the principals and discern what their needs are. They are to listen to the agents and ask, What are their ideas? Then, they need to determine what the optimal amount of resources are needed to go into the enterprise. They need to know what is the optimal amount or range of returns and mix of returns that they will be asking the agents to commit to? Afterwards, they communicate the answer to that question to the principals, providing them with information on what they can expect in exchange for their investment of capital resources.

Through this governance process, either explicitly or implicitly, the board is signaling to management what level of risk the board is prepared to tolerate.

The way in which the governors make this decision is to think about what is in the long-term best interest of the corporation.

How do you decide what’s in the best interest of the corporation? A good place to look is the Supreme Court of Canada’s decision in the lawsuit between Bell Canada Enterprises (BCE) and its bond-holders.

This lawsuit was initiated by the bondholders of BCE when BCE negotiated a sale of the corporation. As part of this negotiated sale, the value of the bondholder’s bonds was going to significantly drop because the parent company was going to have to guarantee the debts of the company being sold.

And so, the bondholders said that the board of BCE was not acting as a fiduciary. What they were doing was acting in the best interest of the shareholders; and in Canada at least, that is not the fiduciary duty of the boards. The fiduciary duty of boards is always to act in the best interest of the corporation even if it is not in the best short-term interest of the shareholder.

In the United States, there had been a case several years earlier than the lawsuit in Canada. In Delaware, the Revlon case ruled that in the instance of an organizational distress such as a hostile takeover, an insolvency, or a windup (when you are winding up to sell a corporation) that the fiduciary duty of the board narrows from the broad interest of the corporation to the short-term interest of the shareholder.

That duty is now called the Revlon duties of the board in the United States. It refers to maximizing the short-term return to shareholders in a distressed situation, in an insolvency or in a sale.

The Revlon duties of a board was what the bondholders in BCE were testing. They were saying, Do we have Revlon duties in Canada? Are you suggesting that the board of directors owes its duty only to the shareholders? The Supreme Court of Canada’s decision stated, No. We don’t have Revlon duties in Canada. The obligation of the board’s duty is to the corporation as a whole. And we want to affirm that it is not a duty of loyalty that is owed to any group. There is no group that has primary loyalty here—including the shareholders.

In fact, the Supreme Court went on to list several stakeholders whose interest the board of directors needs to consider when it is thinking about the best interest of the corporation. There are shareholders, creditors, employees, suppliers, customers, communities, and the public interest.

These seven stakeholder groups must be considered by the board, and all these different stakeholder interests must be kept in mind when the board is determining what is in the best interest of the corporation. The Supreme Court’s clarification of the fiduciary duty of a board is therefore both very helpful but also frustrating because there is no right answer to this question.

In the United States, you can ignore the other six stakeholders in a distressed situation. If you maximize returns to the shareholder, you are good. In Canada as well as in most other countries with fiduciary duty to the board, you must consider these other interests.

Every time you as a governing body are allocating resources and deciding on returns, you should be thinking about the right mix and the right balance. The good news is you can use your business judgment as a board to come up with this weighted balancing of the diverse interests of the stakeholders in the organization.

If you have shown through due diligence and through recording in the minutes that you have, in fact, done that, then a court will not second guess your decision.

This is called the business judgment rule and is what transpired in the bondholders’ case—the Supreme Court of Canada dismissed the case against the bondholders. When they went back and examined the minutes of the meetings of the board of Bell Canada Enterprises, they found that the board was indeed not motivated by just the interest of the shareholders. The board had also looked at the interest of creditors, employees, customers, suppliers, the community, and of the public. The board decided that this particular offer on the table was in the best interest of the majority of those stakeholders and was in the best interest of the corporation. It would keep more jobs. It would satisfy more customers. In addition, the decision would keep more suppliers, communities, and the public paid.

While the offer was going to cost a group of creditors—the bondholders—a lot of money, it was the best deal that was on the table by far. The Supreme Court of Canada agreed with the board by saying, They followed their business judgment. They were a faithful fiduciary to this helpless child—this beneficiary that we call a corporation.

* * * * *

That is why boards exist from an economic point of view. Boards are the independent intermediary between the self-interest of the principals and the self-interest of the agents. They have the ultimate authority and responsibility to be the arbiter or the referee between them. Boards fulfill this responsibility by acting in the best interest of the corporation, looking at the whole array of stakeholder interests and not just those of the owners. This in effect sets the direction for the organization as it goes forward.

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ROLES AND RESPONSIBILITIES

HOW DO BOARDS FULFIL THESE?

Corporate governance is the system by which companies are directed and controlled.

Report of the Committee on the Financial Aspects of Corporate Governance

You will recall that in the last chapter, we looked at why boards exist. In this second chapter, we will look at how boards do their jobs. We will explore the main roles that a board fulfils and what the main tools are that a board uses to fulfil those roles. Further in the book, we will unpack these tools in greater depth.

Following on with the Principal Agent framework we developed in chapter one, we know that boards exist to deal with the self-interest tension that exists between the principals and the agents. A board’s job is to listens to the diverse interests of both the principals and the agents and then decide as an independent arbiter what is in the best long-term interest of the corporation.

We call this the corporate governance system and use the definition that Cadbury gave to corporate governance. Cadbury’s definition is, the system by which the organization is directed and controlled.

DIRECTION

As we look at the board’s roles and the tools that a board uses to fulfil its job, we will begin by concentrating on the board’s roles and responsibilities with respect to direction—the front end of governance. Direction involves lining up the needs of the principals with the best ideas of the agents so that capital can flow and the work of the organization can get done.

We often use the metaphor of a ship to describe the board’s roles and responsibilities in the governance system. If a corporation is a ship, then the board would not be in the boiler room of the ship. The board would not be up on the deck of the ship. The board also would not be up on the highest lookout point on the ship. Arguably, the board would not even be on the bridge of the ship. That is where the CEO and the senior management team would be.

The board would be the rudder of the ship. A huge ship is about one hundred thousand tons, and the rudder of that same ship would only be about eighteen feet high and even narrower than that. By a small shift in that rudder, you can affect the destination of the ship by hundreds or even thousands of miles.

That is what we mean by the board’s role in setting the direction of an organization. It is like setting the rudder of a ship. In some languages, the word for governance and the word for rudder are the same word. That is how closely entwined these two ideas are.

So how does a board set the rudder of the ship? There are five main steps—and related tools—that the board uses.

First, there is the setting of the strategic direction, which involves asking Where are we headed? Secondly, there is the setting of performance and risk direction. Thirdly, there is the setting of people direction—Who will do what? And fourthly, there is the setting of the policy direction, which sets the boundaries for our strategy and operations. Lastly is the allocation of the resources in the organization.

We will start with the most important step: strategic direction. Strategic direction has to do with the setting of the long-term direction of the organization through the approval of a strategy.

One of the most frequent questions we get asked is when does the board get involved in the organization’s strategy?

In some larger private sector corporations, the tradition has been to only engage the board when the management team has already hashed everything out and then drafts a strategic plan to present to the board.

In corporate governance reform, a board gets engaged earlier in the strategic planning process. This does not mean it is the board’s job to do strategic planning. Management always holds the pen! But it does mean that the board is going to be actively engaged in providing input at the front end of the strategic planning process—particularly with respect to the organization’s vision, mission and values. The board should have active input and engagement into those decisions.

The board, as a voice of the principals into the corporation, must meet with the management team early in the strategic planning process before the goals, objectives, measures, and the rest of the planning is done by the management team.

When there are fewer staff members such as in a smaller, not-for-profit organization, the board might play a much more active role in developing the mission, vision, and values. In some cases, they may even be involved in writing them.

Best practice for the development of mission, vision, and values in any organization is for them to be collectively developed by the board and the management. This means collaboration and consensus—wordsmithing the final document is the job of management, as is drafting goals and objectives for further review and discussion at the board level.

The board can then ask questions like, What are the risks we should be concerned about and what are the opportunities that the organization faces and ought to follow and choose? We look at risks and opportunities later in this chapter.

Once obstacles and opportunities are determined, priorities can be established. It is not generally the board’s job to come up with the specific strategies, to deliberate objectives, or to think of all the risks. They can; but the larger the organization, the more work is done between these joint meetings by management, bringing that work to the board for review, dialogue, and finally approval. At the end of the day, it is the board’s job to understand and approve the strategic plan.

Strategy or strategic plan can mean different things to different people because strategic plans have different components and different levels of complexity. But to be effective a strategy must have the following components:

Mission: Why are we here? Why are we in business? Why does the organization exist? What is it that makes this organization unique compared with any other organization anywhere in the community or anywhere in the world?

Vision: Where are we headed in the long-term? How would we describe the state of the world that we will leave behind when this organization has fulfilled its mission? A vision is often a short, pithy statement; and it’s intended to be aspirational, involving some stretch to the organization. You may never achieve your vision. It is always meant to be out there on the horizon for you to aim at.

Not only should the vision be aspirational, it is also meant to be inspirational. It should inspire people—especially the staff. The agents of the organization need to see where they are headed together—to be inspired by a vision.

Mission and vision are the first two elements of a strategic plan. Using the analogy of a ship and a board’s job to set the rudder of a ship, the mission and the vision would be why are we on this ship in the first place and the horizon—that far distant point that you want to reach —would be a point which gives the organization a collective line of sight to a distant horizon. The board, the CEO, the management, the staff, the shareholders, the owners, the other stakeholders, and the principals ought to all be able to see it.

Whether your role is in the boiler room, on the deck or on the mast of the ship, our common purpose is to help us get to that point on the horizon. That is the purpose of the mission and vision. We call that the Horizon Plan.

Values: these represent the non-negotiable boundaries across which it would not be permitted or tolerated for this ship to cross. The ship must stay within these boundaries. Values are those things we believe in and would fight for. Values are not just nice to do, they are need to do or need to avoid in order to sail safely to our desired destination. As we navigate the seas with its winds, waves, currents, and tides, values keep us from striking the rocks or running aground. Values help the organization realize what should be prescribed and prohibited in terms of organizational actions, strategies, behaviours, programs, and projects.

Core values are typically expressed in brief in the strategic plan. They are further articulated in the organization’s Code of Conduct. The Code of Conduct is a policy level direction that the board approves which articulates corporate values—what behaviours and actions are not allowed and are non-negotiable. We will talk about policy direction later in this chapter.

Goals: While we have a horizon to move forward to and we have values to protect us from going off course, we need something in the near-term to aim for. Effective strategic plans set goals. Goals answer the question, What will we accomplish? These need not be long-term goals; but in most strategic plans, you would often find multi-year goals with descriptions of where the organization ought to be headed in several key areas.

How you establish goals will depend on your business model. An organization using a balanced scorecard approach, a model developed by Kaplan and Norton, would have financial, employee, or learning; stakeholder or customer; and quality or process goals. In other organizations, goals may be set up by product lines, geography or stakeholder group.

Objectives: These are key to strategic plans. Sometimes called milestones, they answer the questions, What will we achieve along the way toward accomplishing our goals and living out our mission and heading toward our vision? Using our ship example, if we were going from Los Angeles, California to Shanghai, China, you might say that one of our milestones is to reach Hawaii in four days time.

This illustrates the key elements of an objective. An objective is an interim milestone or benchmark which we must pass along the way towards reaching our destination. It is a shorter-term point that we expect to achieve. It is tangible, realistic and something we can touch. For example, it is very doable to say that we could get to Hawaii. It is also measurable. You know whether you are in Hawaii or not.

As you can see, an objective must be able to be measured and it should also be time bound.

Objectives are not about how we feel. We don’t ask, Do we feel like we are in Hawaii? How do we feel we are doing? Unfortunately, this often happens when it comes to measuring the mission, vision, values, and goals. Being in Hawaii is something we can objectively demonstrate.

Measurable and time bound objectives are essential to strategic plans. Objectives are what gets resourced, they are what gets measured and they are what gets rewarded. The reason we emphasize objectives so much is because at the end of the day it is objectives that really matter in strategic plans. Objectives are what gets resourced, they are what gets measured and they are what gets rewarded. Objectives are arguably the most important deliverable of a strategic plan.

This does not mean you should cut corners on the mission, vision, values, and long-term goals. These elements of your plan are the landscape against which you will be establishing in your specific objectives. Objectives grow out of these. You need that frame, and that frame needs to be robust and something the board and the management team agrees on.

In order to attach measures to objectives, we need to ask ourselves about how to measure whether we’ve arrived at our interim destination or not—how can we prove that met our objective? Sometimes the proof is simply asking if we’ve reached our objective or not—we ask someone if we’re in Hawaii or somewhere else? In other cases, measurement can be precise and quantified—our GPS proves we are in Hawaii. Sometimes, we will have proxy indicators to prove we reached our objective—we’ve met a few people who speak Hawaiian. Whatever the case might be, we must prove that we’ve have met our objective.

We will talkmore about strategic planning and SMART objectives in a later chapter.

The next major role for the board is performance and risk direction. This is simply asking as we set our strategy, What obstacles and opportunities might we face along the way? We define risk as uncertainties that can occur either internally or externally to the corporation that cause us to be uncertain of the returns that we are going to achieve in our economic system.

Turning that into business language, we set objectives, and we approve a budget. However, there is no certainty that that the approved budget is going to achieve those objectives. In fact, there is a range of outcomes for each of the objectives that the board approves in the strategy.

In some areas, our objectives are going to be very difficult to achieve—they are stretch objectives. Achieving these objectives is not just about showing up on Monday morning, and it is a slam dunk. Mission accomplished! There is a risk to the organization that these and other objectives won’t be accomplished as planned.

When boards think of risk direction for the organization, they think of two areas—risk tolerances and risk appetite. Risk tolerances mean that the board and the management team have had a dialogue; and for each of the objectives, they have agreed on a range of possible outcomes that are tolerable. Achieving outcomes within this range is mutually acceptable to the board and management.

Risk appetite is finding out what the sweet spot of taking risks is. What is the optimal zone? What is the optimal range of outcomes for each objective?

By way of example, let’s look at liquidity (also known as cash). An objective is to always have enough cash on hand to cover our payroll and our trade payables. What is the tolerance that the board has about not meeting that objective? If we meet this objective twenty-five out of the twenty-six payroll periods in a year,